A Look At The Fair Value Of INNOX Advanced Materials Co.,Ltd. (KOSDAQ:272290)

Today we'll do a simple run through of a valuation method used to estimate the attractiveness of INNOX Advanced Materials Co.,Ltd. (KOSDAQ:272290) as an investment opportunity by taking the expected future cash flows and discounting them to their present value. We will use the Discounted Cash Flow (DCF) model on this occasion. Models like these may appear beyond the comprehension of a lay person, but they're fairly easy to follow.

Remember though, that there are many ways to estimate a company's value, and a DCF is just one method. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.

See our latest analysis for INNOX Advanced MaterialsLtd

Crunching the numbers

We're using the 2-stage growth model, which simply means we take in account two stages of company's growth. In the initial period the company may have a higher growth rate and the second stage is usually assumed to have a stable growth rate. In the first stage we need to estimate the cash flows to the business over the next ten years. Where possible we use analyst estimates, but when these aren't available we extrapolate the previous free cash flow (FCF) from the last estimate or reported value. We assume companies with shrinking free cash flow will slow their rate of shrinkage, and that companies with growing free cash flow will see their growth rate slow, over this period. We do this to reflect that growth tends to slow more in the early years than it does in later years.

A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, and so the sum of these future cash flows is then discounted to today's value:

10-year free cash flow (FCF) estimate

	2021	2022	2023	2024	2025	2026	2027	2028	2029	2030
Levered FCF (₩, Millions)	₩40.6b	₩41.6b	₩42.6b	₩43.9b	₩45.3b	₩46.8b	₩48.3b	₩50.0b	₩51.8b	₩53.7b
Growth Rate Estimate Source	Analyst x2	Analyst x4	Est @ 2.59%	Est @ 2.92%	Est @ 3.15%	Est @ 3.31%	Est @ 3.42%	Est @ 3.5%	Est @ 3.55%	Est @ 3.59%
Present Value (₩, Millions) Discounted @ 11%	₩36.6k	₩33.8k	₩31.3k	₩29.1k	₩27.1k	₩25.2k	₩23.6k	₩22.0k	₩20.6k	₩19.2k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = ₩269b

The second stage is also known as Terminal Value, this is the business's cash flow after the first stage. The Gordon Growth formula is used to calculate Terminal Value at a future annual growth rate equal to the 5-year average of the 10-year government bond yield of 3.7%. We discount the terminal cash flows to today's value at a cost of equity of 11%.

Terminal Value (TV)= FCF₂₀₃₀ × (1 + g) ÷ (r – g) = ₩54b× (1 + 3.7%) ÷ (11%– 3.7%) = ₩780b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= ₩780b÷ ( 1 + 11%)¹⁰= ₩279b

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is ₩548b. In the final step we divide the equity value by the number of shares outstanding. Relative to the current share price of ₩59k, the company appears around fair value at the time of writing. Remember though, that this is just an approximate valuation, and like any complex formula - garbage in, garbage out.

Important assumptions

We would point out that the most important inputs to a discounted cash flow are the discount rate and of course the actual cash flows. If you don't agree with these result, have a go at the calculation yourself and play with the assumptions. The DCF also does not consider the possible cyclicality of an industry, or a company's future capital requirements, so it does not give a full picture of a company's potential performance. Given that we are looking at INNOX Advanced MaterialsLtd as potential shareholders, the cost of equity is used as the discount rate, rather than the cost of capital (or weighted average cost of capital, WACC) which accounts for debt. In this calculation we've used 11%, which is based on a levered beta of 1.197. Beta is a measure of a stock's volatility, compared to the market as a whole. We get our beta from the industry average beta of globally comparable companies, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable business.

Looking Ahead:

Although the valuation of a company is important, it is only one of many factors that you need to assess for a company. The DCF model is not a perfect stock valuation tool. Rather it should be seen as a guide to "what assumptions need to be true for this stock to be under/overvalued?" For instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. For INNOX Advanced MaterialsLtd, we've compiled three relevant items you should look at:

1. Risks: For instance, we've identified 1 warning sign for INNOX Advanced MaterialsLtd that you should be aware of.
2. Future Earnings: How does A272290's growth rate compare to its peers and the wider market? Dig deeper into the analyst consensus number for the upcoming years by interacting with our free analyst growth expectation chart.
3. Other High Quality Alternatives: Do you like a good all-rounder? Explore our interactive list of high quality stocks to get an idea of what else is out there you may be missing!

PS. The Simply Wall St app conducts a discounted cash flow valuation for every stock on the KOSDAQ every day. If you want to find the calculation for other stocks just search here.

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This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
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